One of the simplest investments available to small investors is the U.S. Saving Bonds, Series EE. They are easy to buy, and they are available in much smaller denominations than other types of bonds. You can buy a savings bond for as little as $25.
Although saving bonds do not pay a high return, the interest they earn is exempt from state and local taxes. You can also get some additional tax savings if you use the bonds for education. Depending on your income, interest earned from the bond is either fully or partially exempt from federal taxes if you use it for college tuition for yourself or your children.
There are some important differences between U.S. saving bonds and other types of bonds. The most common type of savings bond is the Series EE. Those bonds are issued at half their face value. For instance, when you buy a $100 bond, you pay $50 for it. They pay no interest; instead you receive earnings from the bond when you redeem it. So when you redeem a $100 bond - which you paid $50 to buy - you receive the full $100.
In addition to Series EE, the government also offers the Patriot Bond, which was issued after 9/11 and is nearly identical to the Series EE Bonds. One another option is the Series HH bonds, although you can't buy Series HH bonds with cash - you can only get them in exchange for Series EE bonds or upon reinvestment of the proceeds of matured Series H bonds.
Unlike Series EE bonds, Series HH bonds are current-income securities, which means they don't increase in value. Instead, they pay a regular interest payment every six months. When an HH bond is issued, you pay the face amount for the bond. The interest payments on HH bonds are made by direct deposit to your checking or savings account at a financial institution.
The government also recently began offering an "I bond," which is geared to investors seeking to protect the purchasing power of their investment and earn a guaranteed real rate of return. Unlike traditional savings bonds, I bonds are sold at face value and grow in value with a varying interest rate tied to the rate of inflation.
Savings bonds are not limited to the length of their term. In fact, you can redeem them any time - from within 12 months of buying them to as long as 30 years later. After a savings bond reaches its original maturity, it automatically enters one or more extension periods, usually of 10-years duration. Savings bonds stop earning interest when they reach final maturity. For Series EE bonds, final maturity is 30 years, and for Series HH bonds, it is 20 years.
The interest rate on Series EE bonds is not fixed. Instead, they earn interest based on 90 percent of the average yields of five-year Treasury securities for the proceeding six months. U.S. Savings Bonds increase in value every month, and interest is compounded semiannually. Series HH Bonds, on the other hand, have a set rate of interest that does not change until the investor has held the bond for 10 years.
